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John Selwood audit clinic

John revisits some issues around audit work relating to investments, and to pension scheme obligations and disclosures.

Question

Following a recent file review, my firm has been criticised for over-reliance on fund managers’ reports when auditing investments held by charities. Why is this sort of third party confirmation not sufficient audit evidence?

Answer

It is not sufficient audit evidence because it is probably not a third party confirmation at all. It is not uncommon for some auditors to place too much reliance on the investment manager’s year end portfolio valuation. The problem is that very often this has been produced by a ‘service organisation’ and the audited entity does not maintain its own investment records, which means that the year end valuation is not an external confirmation. It is merely an extension of the entity’s accounting records, which are being maintained by a third party.

Indeed, the International Standard on Auditing (UK) 402 Audit considerations relating to an entity using a service organisation specifically says that if the user entity does not maintain independent records, information obtained in confirmations from the service organisation is merely a statement of what is reflected in the records maintained by the service organisation. Therefore, such confirmations do not, taken alone, constitute reliable audit evidence.

This, of course, leads to another question. What should the auditor do in such circumstances?

In general, the auditor is required to understand the entity’s internal controls, which means understanding the internal controls in the service organisation.

A good place to start would be to request what is commonly known as an AAF 01/06 report, which are produced based on guidance in faculty technical release AAF 01/06 Assurance reports on internal controls of service organisations made available to third parties. This is along with other useful resources, such as an article explaining who should be able to view such reports – and how to overcome difficulties in arranging access.

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